Orbis Spólka Akcyjna (WSE:ORB) delivered a less impressive 11.17% ROE over the past year, compared to the 13.48% return generated by its industry. Though ORB’s recent performance is underwhelming, it is useful to understand what ROE is made up of and how it should be interpreted. Knowing these components can change your views on ORB’s below-average returns. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of ORB’s returns. Check out our latest analysis for Orbis Spólka Akcyjna
Breaking down ROE — the mother of all ratios
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. For example, if the company invests PLN1 in the form of equity, it will generate PLN0.11 in earnings from this. Generally speaking, a higher ROE is preferred; however, there are other factors we must also consider before making any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of Orbis Spólka Akcyjna’s equity capital deployed. Its cost of equity is 8.67%. Some of Orbis Spólka Akcyjna’s peers may have a higher ROE but its cost of equity could exceed this return, leading to an unsustainable negative discrepancy i.e. the company spends more than it earns. This is not the case for Orbis Spólka Akcyjna which is reassuring. ROE can be split up into three useful ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. The other component, asset turnover, illustrates how much revenue Orbis Spólka Akcyjna can make from its asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be inflated by excessive debt, we need to examine Orbis Spólka Akcyjna’s debt-to-equity level. The debt-to-equity ratio currently stands at a low 26.08%, meaning Orbis Spólka Akcyjna still has headroom to borrow debt to increase profits.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Although Orbis Spólka Akcyjna’s ROE is underwhelming relative to the industry average, its returns are high enough to cover the cost of equity. Its appropriate level of leverage means investors can be more confident in the sustainability of Orbis Spólka Akcyjna’s return with a possible increase should the company decide to increase its debt levels. Although ROE can be a useful metric, it is only a small part of diligent research.
For Orbis Spólka Akcyjna, I’ve put together three pertinent aspects you should further examine:
- Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Valuation: What is Orbis Spólka Akcyjna worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether Orbis Spólka Akcyjna is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Orbis Spólka Akcyjna? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.